Network effect

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{system, computer, user}
{company, market, business}
{rate, high, increase}
{theory, work, human}
{work, book, publish}
{math, energy, light}
{math, number, function}
{line, north, south}

In economics and business, a network effect (also called network externality) is the effect that one user of a good or service has on the value of that product to other people. When network effect is present, the value of a product or service increases as more people use it.

The classic example is the telephone. The more people own telephones, the more valuable the telephone is to each owner. This creates a positive externality because a user may purchase their phone without intending to create value for other users, but does so in any case. Online social networks work in the same way, with sites like Twitter and Facebook being more useful the more users join.

The expression "network effect" is applied most commonly to positive network externalities as in the case of the telephone. Negative network externalities can also occur, where more users make a product less valuable, but are more commonly referred to as "congestion" (as in traffic congestion or network congestion).

Over time, positive network effects can create a bandwagon effect as the network becomes more valuable and more people join, in a positive feedback loop.

Contents

Origins

Network effects were a central theme in the arguments of Theodore Vail, the first post patent president of Bell Telephone, in gaining a monopoly on US telephone services. In 1908, when he presented the concept in Bell's annual report, there were over 4000 local and regional telephone exchanges, most of which were eventually merged into the Bell System. The economics of network effects were presented in a paper by Bell employee N. Lytkins in 1917, where the term "network externality" was used.[citation needed]

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